Rule #1 Finance Blog

With Investor Phil Town

YOUR HOMEWORK: SNDA (SHANDA INTERACTIVE)

Here’s a new homework.

While I was in Europe Alan contacted me with his YUMMMMY analysis of SNDAShanda Interactive Entertainment Limited. Shanda is a Chinese home entertainment company specializing in online gaming (interactive video games, mostly).

Here’s his analysis and my response:

[Edited for length]

From: Alan
Date: Jun 30, 2005
To: Phil

Am I correct on SNDA?  Here are my worksheet numbers:

EPS: $1.04.  Past growth: 43.50%.  Fill in 5 year sales EPS growth.  Future PE = 87. Double growth rate don’t fill in. EPS in 2015: $38.51. 22 X FV of 2.32 @ 22% eps growth don’t fill in. Value per share 2015: $3,350.21. Don’t fill in. Sticker Price: $828.12. Present value less 15% gain. Price We Want: $414.06 — 1/2 of reasonable price. The 43.50% growth comes from consensus estimates.

That says that this $36 stock should trade at $414? HELP!  I must be off or should I buy a boat-load?

I hope to hear back…

Al


Dear Al,

Do not buy a boatload … yet.  Let’s go through the issues: 

First, the business has only four years of data.  Automatically that puts it in the Risky Biz portfolio.  In addition, you have to remember to do the LESSER of things when you have a choice.

Here are what I call the Big Five numbers:

ROIC 40%.  Awesome

Equity Growth Rate (the best number to use for long term growth): 58%  Huge.  Too big to hope for.  The next best number is EPS.

EPS Growth Rate: 70%.  Still too huge!

Sales Growth Rate: 100%  Still too huge!

Cash Flow Growth Rate: 50%  Still huge.

But we gotta decide a growth rate for the future.  This is totaly ballparking on a business that is not — for me — at all predictable because it is too new in a business whose Moat I don’t understand.  So tell me what their moat is, since the Big Five point to one.  Meanwhile, I’ll ballpark their long term growth at 50%.  Ridiculously huge.

Check debt while we’re at it.  275 mil just got added outta nowhere and it’s all in cash. Wonder what they borrowed it for?  Do you know?

So the numbers are huge and they just borrowed a pile they can’t pay off real quickly out of earnings.  Hmmmm.

MOS:  You need three things:

1.  Current EPS:  $1.20

2.  Future EPS Growth Rate:  the lower of analysts estimates or our estimate of 50%.  Analysts guess 35%.  So 35% for growth rate.

3.  Future PE: the lower of historical or 2 times the growth rate of 35% – 70.  The historical PE is 28.  So 28.

Calculate the Future value and you should get $675 per share.  To get our minimum 15% return we have to buy it for $166.  The MOS on that is $83.  The actual price is $34.

So.  Not quite the deal you thought it was but still a very very nice discount to value, remembering that we really don’t know the value because of the track record being so short.

Bottom line: nice find.  Now go do your homework and tell us why you love the CEO and what the Moat is on this thing.  It sure isn’t Brand. 

Is it a Toll Moat – you have to pay to play?  Or a Secrets Moat – you can’t compete because no one else can do what they do?  Or is it a Switch Moat that makes you lose all kinds of friends and game scores if you switch?  Could be they have all three?  Even a price moat?

I love gaming on line.  So come back and show me that you have mastered this business and know why they will win.  Then we’ll all go buy it!